How to Play IBM Investor Day With Stock Options

By

Steven M. Sears

July 30, 2019 5:30 am ET

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International Business Machines
(IBM) stock options are priced liked a 99-pound weakling ahead of a major event that could redefine how investors view the company’s management team, corporate strategy, earnings outlook and stock valuation.

IBM’s stock, which is part of the
Dow Jones Industrial Average,
normally moves about 5% around earnings, so it seems that the options market is disconnected from the reality of an event that may arguably be even more important than an earnings report. Such disconnects often happen in the options market because automated pricing models do not have a way to easily price multifaceted events that are more nuanced than just looking back in time to see how the stock has moved and then extrapolating about future stock movements.

This creates opportunities for investors to aggressively pre-position in anticipation that IBM’s investor briefing will be filled with precisely the kind of information that appeals to investors but that options pricing models cannot adequately reflect.

The challenge for IBM’s management is to back up with numbers and forecasts some of the bombastic language it has used when discussing the Red Hat deal. If that is done well, it should secure the stock’s recent advance and lead sell-side bank analysts to raise earnings estimates.

So far this year, IBM’s stock is up about 33%, a sign that investors like the Red Hat deal. But for the past year, the stock has barely budged. It is up about 4%. Most stock analysts are not enthusiastic about IBM despite the big stock move.

But that could change as cloud computing seems to have a steroidal, catnip effect for anyone who comes near it—especially stodgy old technology companies that have seemingly lost their mojo.

Remember
Microsoft
(MSFT). The company’s best days seemed so far behind it that the best thing that could be said about the stock was that it paid a nice dividend. And then Microsoft pursued cloud computing and suddenly the company and stock are back in the warm graces of Wall Street. Moreover, cloud computing is one of
Amazon.com’s
(AMZN) great business divisions, which adds a halo effect to the business.

IBM will never be Amazon, but it might be Microsoft, which was once as stolid, and rudderless as IBM’s until it used the cloud to revitalize the company. If IBM can convince the Street that it is a Microsoft 2.0 kind of story, the stock could move.

JPMorgan’s derivative strategists are recommending that investors “straddle” the stock by buying August $150 calls and puts that expire Aug. 9. The trade pays off if the stock moves, up or down.

But the moment at hand seems to merit a bolder bet on direction.

It seems unlikely that IBM’s management team will do or say anything that takes away from the excitement it has already generated with the Red Hat deal. For that reason, aggressive traders—don’t use your kid’s college money for this—should buy IBM’s August $152.50 call that expires Aug. 9. A call that expires one week after the event was chosen over this Friday’s expiration to give analysts time to update their models and issue notes.

With the stock at $151.36, investors could buy IBM’s August $152.50 call that expires Aug. 9 for $1.51. If the stock is at $160, the call is worth $7.50. If the stock is below the strike price at expiration, this trade fails. The stock has ranged from $105.94 to $154.36 during the past 52 weeks.

For the trade to be a winner, IBM’s management team must say something that persuades analysts to bullishly change their mind. The message doesn’t even have to be that profound because the concerns of some analysts are easily addressable by IBM’s management.

“Our analyst is taking a wait-and-see view on the deal impact, and recognizes the potential energizing growth from the deal, but also lacks conviction on the near-term upside potential from the deal given the work needed for cultural integration, potentially messy accounting and the suspension of its buyback program,” Shawn Quigg, a JPMorgan derivatives strategist recently wrote to his clients.

Such cautiousness is often bullish for stocks because it indicates significant room for investment opinions to change for the better. More than 60% of the street has a Neutral rating on IBM, and many analysts, including like JPMorgan’s, have likely not updated their earnings models to reflect the Red Hat deal and therein lies the potential upside.

How to Play IBM Investor Day With Stock Options

International Business Machines (IBM) stock options are priced liked a 99-pound weakling ahead of a major event that could redefine how investors view the company’s management team, corporate strategy, earnings outlook and stock valuation.

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